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Scenarios: Can Greece cut its deficit by 10 points in 2 years?
ATHENS (Reuters) - Greece, the IMF and the European Union are discussing austerity measures aimed at cutting the country's deficit by 10 percentage points of GDP in 2010 and 2011, labor union leaders said, a goal that could deepen recession and spark a public backlash.
Labor union leaders said the measures under discussion include more tax hikes and even steeper cuts in wages and bonuses than announced by the government last month, as well as the elimination of full-time jobs in the public sector.
The new budget objective would exceed the country's current target of cutting the deficit by 7.1 percent of gross domestic product in two years -- from a 2009 level of 13.9 percent of GDP -- and push forward its goal of bringing the shortfall to near the EU prescribed level of 3 percent by 2012.
In a three-year stability and growth plan agreed with the European Commission, Greece planned to narrow the budget shortfall to 8.7 percent of GDP this year and bring it to below the euro zone's 3 percent by 2012.
Based on the labor leaders' statements, conversations with analysts, fiscal targets set out in the stability and growth plan, and comparisons of other EU/IMF bailouts, here are three scenarios Greece faces, with implications for financial markets:
GOVERNMENT MEETS OR EXCEEDS FISCAL TARGETS
SCENARIO: Helped by extra austerity measures and a crackdown on waste and tax evasion, the government manages to cut the deficit by 10 percentage points by the end of next year.
PROBABILITY: Very low. Further austerity measures are expected to hurt an economy already in the doldrums. The IMF already expects the economy to contract by 2 percent this year and by 1.1 percent in 2011, making it Greece's longest recession in 30 years. Some economists expect domestic demand to contract even more, by about 5 percent.
Additional belt-tightening would hurt the economy further, analysts say. That would undermine income tax revenues and make it tough for the government to achieve its already ambitious target of boosting net tax income by 11.7 percent this year.
MARKET IMPLICATIONS: A deficit cut of 10 percentage points within two years would be a positive surprise for investors and make it easier for Greece to tap financial markets sooner, perhaps even next year.
GREECE WIDELY MISSES BUDGET TARGETS
SCENARIO: The economy shrinks by more than 4 percent, with tax revenues collapsing and Greece widely missing its deficit targets.
PROBABILITY: Average. Recession deeper than 4 percent with unemployment rate soaring well past the 12 percent is expected to intensify social unrest and could prevent socialist Prime Minister George Papandreou's government for pushing reforms, and labor unions have already vowed to resist further austerity.
Even without social unrest, cutting deficits in times of economic downturn is extremely difficult, as shown in the examples of three non-euro-zone EU states that pledged to trim public finance shortfalls as part of EU and IMF aid packages.
Latvia agreed with the IMF to aim for a fiscal deficit of 5 percent of GDP last year but ended with almost double that after austerity measures exacerbated an economic contraction of 18 percent that was more than three times worse than forecast.
IMF borrower Romania also saw its deficit rise from an original pledge of 4.6 percent of GDP in 2009 to 8.3 percent, and Hungary originally pledged to a 2.9 percent of GDP deficit, but finished at 4 percent. All three had to renegotiate targets.
MARKET IMPLICATIONS: Political instability in Greece would destroy any hope of Greece managing its debt, increasing the prospects of a debt restructuring or default. This would raise pressure on Greece to withdraw from the euro zone, at least temporarily, and could undermine the credibility of the European single currency. It would also raise market pressure on euro zone periphery states like Portugal and Spain, potentially making it more expensive for them to borrow.
GREECE CUTS DEFICIT MODERATELY, MISSES TARGET
SCENARIO: The new measures lead to even deeper recession but the size of the tax increases and spending cuts are too great to allow the government to narrow the deficit by 10 percentage points of GDP over two years.
PROBABILITY: High. The Greek public sector is in such disarray that even elementary spending and structural reforms could generate significant deficit cuts, even in case of very deep recession. The government has already legislated wage and pension cuts in the public sector of about 2.7 billion euros.
Defense spending cuts of 460 million euros are also underway. The government has capped pharmaceuticals prices by about 1 billion euros to limit hospital spending. The EU has pledged to speed up disbursement of an extra 1.4 billion euros earmarked for infrastructure.
A new hike of VAT and excise taxes would help Greece exceed a current target of an additional 6.1 billion euros in revenues from VAT and other taxes this year,
But deeper recession would mean higher unemployment and cast doubt on plans to reduce social security subsidies by at least 540 million euros and raise about 1.7 billion euros by cracking down on tax evasion.
MARKET IMPLICATIONS: A deficit cut of 3-4 percentage points per year would not be a surprise but would create the impression that Greece has fallen short of its targets, shaking further investor confidence and delaying the nation's return to markets.
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